Many businesses that eventually utilize the R & D credit, had no knowledge
about the credit, or thought their business did not qualify. Often, these businesses
have a “traditional” understanding of R & D activities believing that only
companies with employees in lab coats who are experimenting with chemicals
would qualify.
For these reasons, it is critical to understand that the IRS definition within the
Internal Revenue Code Section 41 defines R & D simply as the design or development of a new or improved
product or process. Yes, the design must be somewhat technical in nature
and there is a requirement of an experimentation process, however, once the
basic definition is understood, companies such as machine shops, fabrication
shops, tool and die and other manufacturing firms which conduct R & D
activities on a daily basis, need to consider the opportunity for cash benefits
and credits.
Additional activities that qualify for benefits will include those entities
participating in CAD (computer automated design), modeling, first article,
prototyping, CNC machines, laser technology, grinding, de-burring, and quality
assurance activities. In addition, companies implementing proprietary software
into their company may also qualify for the credit.
The R & D tax credit provides taxpayers with very generous benefits. The
credit is wage based and depending on the credit computation selected, can
provide a credit benefit of up to 20% of Qualified Research Expenditures
(QREs). The IRS allows companies to amend three prior open tax years in order
to claim the credit from previous years. Credits can also carry forward up to
20 years.
The following short case study for a
Manufacturing Company in Texas exemplifies the benefits of the credit as
follows:
The Texas Company’s employee’s
activities included CNC machine activity, grinding, fabrication and CAD. The
total payroll was around $2 million a year for each tax year 2004 – 2008. The
credit benefit the client ultimately received was about $215,000.
Approximately 70% of US manufacturing entities are eligible for R&D
type of benefits. As more companies become educated on the benefits and take
steps to claim the credits that are available from the IRS, it is likely that
this percent will increase. Certainly, the credit, which is a dollar for dollar
reduction of a company’s tax bite, has assisted many entities (and their
owners) who have experienced cash flow issues due to the economic downturn and
the freeze in lending.
In order to support the expenses eligible for the credit, information must be
gathered and analyzed. The supporting documentation may include a detailed
engineering report explaining qualifying activities accompanied by the
methodology of how the calculations were prepared in order to substantiate the
benefits.
A full R&D study is likely to be technical in nature and should require an
in depth knowledge and understanding of the company’s activities, products, and
processes. Many times an engineering professional and tax professionals work as
a team in conducting the R & D tax credit study analysis. Third party
firms, which specialize in these specific studies, are also an alternative.
